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Markets ease only for a while after US debt deal

MNB

Resolution of the US debt-ceiling impasse could ease the immediate crisis, which has threatened with global economic consequences, but repercussions will still be felt for years to come, analysts say.

With effects of the turmoil caused by the Greek debt crisis not even settled, now the lengthy negotiations on raising the debt ceiling in the US threaten financial markets in the entire world, and Hungary is obviously not an exception. Late Sunday night, US President Barack Obama announced that they have reached a last-ditch deal. It was approved by the Senate on Monday, but is yet to be passed through the Senate, which is expected on Tuesday. As a first reaction to the developments, money markets started to liven up Monday morning. The positive sentiment, however, will only be temporary, both on a global level and in Hungary, analysts say.

The Hungarian currency, dragged by the Greek crisis in the last few weeks, is now seeing volatile movements again. It traded against the Swiss franc at a record low on July 29, at above 239 versus the franc. After the promising news broke on the US negotiations, the tension eased a little, and the forint traded at 234.57 to the CHF on Monday morning.

But markets’ relief was short-lived: as the day went by on Monday, the Swiss franc started to fly again, and traded at a record high against the euro and the US dollar. This, naturally, resulted in a weaker forint again. During the day on Monday, the forint slipped past the 244 mark for a short time, just to recover slightly to 242.08 by the end of the day.

After prolonged and heated debates, Washington lawmakers may yet evade catastrophic debt limit default set for August 2 by forging their varied opinions into what US President Barack Obama has called “not the greatest deal” but “a good down payment.”

The current negotiations have aimed at raising the US debt limit from the current $14.3 trillion ceiling by an estimated $2.4 trillion. Without an agreement, the US faces the possibility of default on the repayment of its loans for the first time in history. A default could see the credit rating downgrade from the top-notch “AAA.” A downgrade would raise interest rates for borrowers and deal a devastating blow to the already lethargic US economy as well as to the dollar as a global currency.

The world economy has been hinged on the outcome of the Washington debates, as the result will have global effects. The importance of this pivotal decision is balanced in the hands of politicians in Washington who have been dueling for their preferred budget cuts for months. The proposed plan as is will reduce the US deficit by $2.4 trillion (an equal level to the increase in debt allowance) during the next ten years.

The slow debates in Washington have sparked global alarm, inciting comments that the US is playing a reckless game with the world economy, pushing the decision to the final August 2 date when the US would effectively run out of cash to pay its bills. Global markets have been stormy, culminating in the DJIA biggest one-week losses in over a year on Friday July 29, but have seen reprieve as news of a deal has transpired.

The threat of defaulting on debt repayment was revealed to Congress by Secretary of Treasury Timothy Geithner in January. Lawmakers went to action, but have been criticized heavily for the slow speed and inability to form a deal. The partisan divides continued up until Sunday when a promising incarnation was proposed, however, there is no guarantee.

The legislation needs to reach Obama's desk by Tuesday at the latest. If the current $14.3 trillion debt limit is not increased by that point, Americans could face rapidly rising interest rates, a falling dollar and shakier financial markets, among other problems. The imminence of the Washington decision is clear, and time is short to sort out the predicament and calm the world’s economic waters.

Strong franc is here to stay

The Swiss franc is likely to firm further on fears ratings agencies could downgrade US government debt. Three major rating agencies – Moody’s, Standard & Poor’s and Fitch – have already warned on the possibility of the US losing its top AAA grade. In spite of the debt deal on Sunday, analysts say that downgrade is still a significant risk over the coming months, as rating agencies may not view the plan as going far enough to reduce the deficit.

“The main question is how the US government will manage to solve its debt problems in the long run,” Erste Bank analyst Zoltán Árokszállási told the Budapest Business Journal. “In my opinion, tension will not ease anytime soon, and its effects will be felt in the years to come.”

According to him, notable changes in the forint-Swiss franc exchange rate are not on the horizon.

“With a very good scenario in the longer run, the forint might strengthen to below 200 versus the Swiss currency, but this is not likely to happen for another year or two.”

Tamás Gerőcs, an analyst with Equilor, agrees.

“The exchange rate greatly depends on international tendencies, and as far as I see it, risks remain significant for quite a while. I do not except a notably strengthening forint in the near future,” he said.

All these are bad news in bad times. Just most recently, The Financial Times reported on an analysis by Citigroup Global Markets which predicts a possibility of a spill-over of the eurozone crisis to emerging Europe through trade channels and banking sectors.

The so-called Contagion Index shows that Hungary (along with the Czech Republic, Poland, and Turkey) is most at risk if the eurozone crisis spreads beyond the periphery. On a scale of 0 to 1, with 1 being the highest degree of vulnerability, Hungary received 0.65 – the highest in the region.

Hungary is not threatened by a solvency crisis, but due to its high external financial requirements, it is utterly vulnerable to a fresh liquidity squeeze, the Citigroup report concluded.

(Clifford Dallon has contributed to this article)

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